Audit updates: June 2014

The latest audit roundup from audit reform timetable in the UK to FRC head Sir Win Bischoff defends Big Four, while Worthington Nicholls auditor faces regulator disciplinary board

The new chairman of the Financial Reporting Council, Win Bischoff, was forced to defend the dominance of the Big Four firms in the audit market at his appointment hearing before the Treasury Committee today.

At a relatively short hearing, Bischoff was repeatedly questioned on the concentration of the Big Four as auditors of the largest listed companies and the lack of competition in the market. ‘In ideal circumstances we would have more, say the Big Six, particularly when you are talking about auditor rotation,’ he said. However, when pressed he said that the problem was mainly at the FTSE 100 level and did not filter down to the FTSE 350.

Bischoff said: ‘The concentration is largely at the FTSE 100 rather than FTSE 300 end of the audit market. It is difficult to find those auditors at the next level – there are only four firms at the moment. One of the arguments is that only the big firms have the global scale.’

In reality, audit contracts are still concentrated in the hands of a minority of firms outside the FTSE 100. Only 4.4% of FTSE 250 firms are audited by non-Big Four auditors, Grant Thornton and BDO, as opposed to the Big Four.

But he added that some of the blame for the audit concentration rested with companies who were not prepared to use non-Big Four firms. ‘It is not only the audit firms – not that I want to defend the audit firms – but it is also the corporates who are looking to hire auditors.’

On the question of whether the Big Four – PwC, Deloitte, KPMG and EY – were too big to fail, he said: ‘I think they are too big to fail – I suspect if there were a major problem we would need to be more thoughtful than we were about Arthur Andersen’. He stressed that the firms were unlikely to fail because of their structure, which means that ‘only part of the firm would fail’.

The Committee members also questioned ‘the cosy relationship between the Big Four and the banks’, particularly the tendency for audit firms to provide extensive consulting and other services to their banking clients.

Bischoff batted this back by calling for more effective audit committees. He said: The audit committees need to make sure that they balance the audit and consulting services. It is

Andrew Tyrie, chairman of the Treasury Committee, said: ‘You are certainly well qualified to do the job unlike some of the witnesses we have seen this year.’ However, Labour MP John Mann questioned Bischoff’s credibility as the head of the country’s accounting and audit regulator and overseer of corporate governance in light of his previous roles at Citigroup and later Lloyds Group. ‘One of the problems is that you are one of the insiders and yet you emerge as responsible for overseeing corporate governance in the sector,’ said Mann.

Bischoff said that ‘I was a senior member of the management team at Citigroup’, but he joined Lloyds Group after the crash in 2009.

Co-operative Bank ends 40-year audit contract with KPMG

EY is to replace KPMG as auditors of the troubled Co-operative Bank, ending a 40-year auditing relationship

The Co-operative Bank said it had put its audit out to tender earlier this year and that KPMG had not tendered.

In January the Financial Reporting Council (FRC) launched a formal investigation into KPMG’s audit work for the Co-operative Bank under the Accountancy Scheme into the preparation, approval and audit of the financial statements of the bank for certain years up to and including the year ended 31 December 2012.

The bank said the FRC’s move was just one the reasons for the decision to replace the auditors. Its statement said others included the bank’s separation from the Co-operative Group (for which KPMG remain the auditors), and the board's intention to adhere to the forthcoming requirement to ensure companies put their audit work out to tender at least once every 10 years.

The FRC investigation follows the regulator’s inquiry in the bank’s accounts and KPMG’s role as auditors which began November 2013. At the time, the bank said this related to ‘the disclosure in the 2012 annual report and accounts of the bank's regulatory capital position. They also relate to the bank’s loan impairment, impairment of its investment in its replacement banking IT platform, and to fair value disclosures.’

The Co-operative thanked KPMG ‘for the support they have given the new management team over the last 12 months’.

EY's head of audit for financial services, EMEIA, Isabelle Santenac, said the firm is proud to be selected as the auditor of The Co-operative Bank.

'We recognise the bank is going through a difficult period in its history. The new management and leadership team have outlined a strategy and plan to take the business forward, we are pleased they have taken the opportunity at this stage to review their advisors and invited EY to become their new auditors. We look forward to working with the board and management during the turnaround and transformation of the business,' she said.

News of the change of auditor comes on the same day as the publication of Sir Christopher Kelly’s report into the events which resulted in the bank revealing a  £1.5bn capital shortfall last year, bringing it close to collapse.

The report concluded that the Co-operative Bank’s problems stemmed from its 2009 takeover of the Britannia Building Society and poor management controls.

The terms of reference for Kelly’s review included looking at the financial accounting practices of the bank and the role of the independent auditors. However, in the report Kelly states he did not look at KPMG’s ‘detailed workings’, although he refers to the findings of the Financial Reporting Council’s Audit Quality Review (AQR) team which examined KPMG’s audit of the 2011 Financial Statements.

This concluded that the firm’s audit work was ‘of an acceptable overall standard with improvements required’.

Kelly said he looked at the accounting disclosures in three specific areas: a bond issued by the Britannia Building Society; the way an overhaul of the IT systems was accounted for; and the handling of impairments on corporate loans. ‘With hindsight some of the accounting judgements might have proved to be inappropriate. But that does not necessarily mean that they were unreasonable at the time,’ Kelly said.

UK reform will go ahead as planned, says CMA

The competitions regulator is considering reforms to the audit market, announced by the European Commission earlier this month and is set to release a final package of measures for the UK, in line with its administrative work plan announced in January.

The then Competitions Commission – now the Competition & Markets Authority (CMA), which has absorbed the work of the Competition Commission - had twice previously revised its administrative timetable.

In January it indicated intentions to delay release of the final orders to ensure any UK legislation was in line with the EU reforms, in order to avoid creating any duplication or contradiction.

The CMA has now confirmed it is currently working on redrafting the orders, which have already been subject to one informal consultation at the end of last year.

According to the administrative timetable, the CMA will now hold a second informal consultation on the revised drafts with key parties in Q2 2014, followed by a 30-day formal public consultation on the text.

The new rules, which include the requirement that all FTSE 350 companies put their statutory audit engagement out to tender at least every ten years, are set to be finalised in Q3 and will come into force by the end of 2014.

The CMA’s administrative timetable is here:

Worthington Nicholls faces FRC disciplinary hearing

The disciplinary hearing into the conduct of auditor Paul Newsham in connection with audits of the financial statements of the Worthington Nicholls Group (WNG) and its predecessor businesses started on 19 May, as the auditor faced the Financial Reporting Council (FRC).

The formal complaint hearing began on 19 May and is expected to last for three weeks. Back in July 2013, the FRC announced plans to investigate Newsham over alleged misconduct in relation to actions taken in identifying potential audit issues in planning WNG audits, the accounting policies adopted and audit evidence obtained, and the quality control and closure of the audit for each of the financial years 2004, 2005, 2006 and the interim 2006.

The original complaint alleged that the conduct of Sixonethreeone, the audit firm formerly known as HWCA, and Newsham fell short of the standards reasonably to be expected of ICAEW members and member firms, in that they failed to act in accordance with the ICAEW's code of ethics’ fundamental principle to act with professional competence and due care.

WNG supplied heating and ventilation units to hotels and joined the AIM market in 2006. The Serious Fraud Office (SFO) began an investigation into the company in March 2008, after allegations that it had made a number of misleading announcements to the market following its listing which led investors to buy shares at artificially inflated prices. The investigation looked at around £30m of share purchases, but the SFO announced in 2013 that it would not be bringing a court case as it did not feel it had a reasonable prospect of conviction.

At its peak in April 2007, WNG’s market capitalisation was £146.3m and the share price 199p. However, when the interims to 31 March were published in June 2007, they revealed an operating loss of £174,000. A series of profits warnings were given, the WNG board was replaced and Deloitte took over as auditors. By 31 December 2007, WNG was capitalised at £12.6m and its share price was 14p.

In November 2012, an FRC disciplinary tribunal made findings of misconduct against Timothy Hunt, WNG's former finance director, who was excluded as a member.

EY set to audit London Stock Exchange

PwC has lost the audit contract for the London Stock Exchange Group (LSEG), as KPMG takes over as external auditors. PwC has handled the audit since 1998.

The decision follows a competitive tender process which LSEG announced at the end of last year and which was overseen by its audit committee who made the recommendation for the switch, which has been approved by the board.

EY’s appointment will take place shortly after the completion of the audit of LSEG's consolidated accounts for the year ended 31 March 2014 by PwC, and will be recommended to shareholders for approval at the AGM in July 2014.

According to LSEG’s 2013 annual report, PwC received £200,000 for auditing the parent company, £1m for auditing its subsidiaries, and a further £400,000 for other assurance services.

The firm was also paid £900,000 for non-audit services, largely relating to due diligence work associated with the exchange’s acquisition of a majority shareholding in LCH Clearnet Group Ltd.

BDO tops FTSE AIM audit list

The largest share of the AIM audit market is held by BDO, while KPMG now has the most FTSE AIM 100 audits, according the latest survey from Adviser Rankings.

The quarterly AIM rankings shows BDO retaining the top position overall with 163 AIM clients following a gain of two clients, followed by Grant Thornton with 146. KPMG holds third position with 139 clients after a gain of three, while PwC is in fourth position and the firm’s number of clients (112) remains unchanged. Deloitte is fifth, dropping one client to 88.

However, in the FTSE AIM 100 KPMG now tops the table with 25 clients, after a gain of three, displacing PwC which drops to second place with 24 clients, followed by EY with 11 clients. Deloitte moves down to joint fourth alongside BDO with 10 clients, having lost three clients in the quarter. 

PwC retains the top ranking by client market cap, with £18.3bn. The top five listing remains unchanged, with KPMG in second place with AIM audit clients worth £16bn by market cap, ahead of Deloitte (£8.8bn), Grant Thornton (£8.4bn) and BDO (£8.3bn).

Nexia Smith & Williamson enters the rankings for both FTSE AIM 100 (two clients) and FTSE AIM UK 50 (one client) for the first time. The firm has 25 AIM audit clients.

In the consumer goods category, Grant Thornton moves up to share joint first with eight clients, alongside KPMG and PwC. This means Grant Thornton has the top position in five categories: consumer goods, consumer services, healthcare, industrials, and technology.

The rankings are compiled by Advisers Rankings from data supplied by Morningstar.

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